On Balance: Teachable Moments in Benefit-Cost Analysis: From Obama to Trump

March 7, 2018

By Elisabeth Gilmore

As a teacher of benefit-cost analysis (BCA), I find that current events often provide "teachable moments". The review by the current administration of the Clean Power Plan (CPP), a cornerstone of the Obama era climate change regulations, is one such event. Federal regulations that may have significant impacts on segments of the economy are subject to an assessment that contains a BCA. The CPP adopted under the Obama administration was accompanied by a finding that benefits exceeded costs. However, the revised estimates produced by the Trump administration indicate that costs exceed benefits. Each year, many students in my class question the usefulness of BCA in promoting good policy, often asking whether the BCA framework is too flexible, and therefore meaningless. Does this example support their skepticism? I am anticipating some tough questions from my students and here’s how I plan to answer them.

As a teacher of benefit-cost analysis (BCA), the review by the current administration of the Clean Power Plan (CPP), a cornerstone of the Obama era climate change regulations, presents what we often call “teachable moments.” Specifically, how could the CPP produce benefits that exceed costs in the Obama administration and then costs that exceed benefits in the Trump administration?

In 2015, the Environmental Protection Agency (EPA) announced the CPP , which set standards for electricity generating power plants and guidelines for state-level plans, with a goal of reducing carbon dioxide (CO2) emissions by 32 % by 2030 compared to 2005. As an economically significant regulatory action, the CPP was subject to a benefit-cost analysis (BCA) as required under Executive Order No. 12866 and Circular A-4 from the Office of Management and Budget. The analysis indicated that the benefits of regulation outweighed the costs.

However, by altering the discount rate for climate damages and the choice of “whose damages count” (global damages or only those to the United States), the BCA for the proposed repeal calculates that the SC-CO2 (for emissions in the year 2015) could be as little as $1 (2011$). By contrast, the Obama administration calculated and adopted a value of $36 (2007$) in the BCA for the CPP .

Each year, many students in my class question the usefulness of BCA in promoting good policy, often asking whether the BCA framework is too flexible, and therefore meaningless. Does this example support their skepticism? I am anticipating some tough questions from my students and here’s how I plan to answer them.

Question: One key difference between the values used for the SC-CO2 comes down to whose benefits and preferences should be included in the analysis. Who makes this decision?

Answer: The short answer is that BCA alone cannot guide us as to who has standing. While there is consensus that climate change is a global problem and that the most efficient policy would internalize the global social cost of CO2 emissions, there is less agreement about whether it is appropriate for the US government to consider damages to those living outside the United States. Two recent papers – the first by Gayer & Viscusi (2016) and the second by Howard & Schwartz (2016) – present divergent views and raise questions about precedent, legal authority, international reciprocity, and altruism towards inhabitants of other countries.

Practical constraints are also important; the Interagency Working Group in 2010 estimated a domestic value of between 7 to 23% of the global value, but termed that value “approximate, provisional, and highly speculative .” Consequently, it is recognized that an improved domestic estimate would be needed to support its use in future BCAs. That being said, the question of who has standing is as much ethical and political as it is legal or practical.

Question: The SC-CO2 was calculated by the Interagency Working Group using three discount rates, 2.5%, 3% and 5%. For the BCA for the CPP rule, the results for a 3% discount rate were selected. In the review of the rule, the results are presented for 3% and 7%. The discount rate is critical for climate change policies where the benefits may not be observed until the middle of the century. So, who “picks” the discount rate?

Answer: The practice of discounting is based on the well-established principle that a dollar today is worth more than a dollar tomorrow. The existing guidance from the U.S. Office of Management and Budget (OMB) Circular A-4 suggests using discount rates of both 3% and 7% for valuing costs and benefits in a regulatory context, and this is the approach taken in the review. These rates are based on empirical rates of return in the market and risk-free government bonds as indications of a social preference for present versus future dollars. For policies with costs and benefits than span generations—such as climate change—the rationale for using these rates is less clear.

There is ample support (both in theory and in practice) for applying lower and declining discount rates for policies with intergenerational benefits and costs (Arrow et al. 2013). OMB concurs that if the rule will have “important intergenerational benefits or costs, you might consider a further sensitivity analysis using a lower but positive discount rate.” Furthermore, recognizing the uncertainty in the discount rate, the recent report on Valuing Climate Damages from the National Academies suggests a discounting model for climate impacts that “explicitly recognizes the uncertainty surrounding discount rates over long time horizons,” the relationships between discount rates and economic growth, and the economic impacts of climate damages.

While different discount rates may be appropriate under different circumstances, the selection of discount rates for a BCA should always be clearly justified given the policy under consideration, drawing on conceptually sound frameworks and explicit treatment of uncertainty.

Question: Considering that, at least for the SC-CO2, alternative specifications of key variables can lead to very divergent outcomes, is BCA still useful for impartial, evidence-based policy?

Answer: Regardless of the results of the economic analysis, the final decision always rests with elected and/or appointed decision-makers. In the case of the SCC-CO2 used in the CPP, considerable debate focuses on the extent to which the methods and assumptions made in calculating the value reflect sound science. But, in part, the choices of discount rate and of “who has standing” reflect differences in the perspectives of different decision makers on how to treat future generations and people outside the US in public policy.

This does not, however, reduce the role of BCA in developing good policy. First, the theoretical origins of BCA rest on strong underlying principles for evaluating whether an action provides an overall benefit to society, and BCA’s role in policy-making has been reaffirmed by both Republican and Democratic administrations.

Second – and perhaps more importantly – BCA provides a framework for recording the basis for policy actions and forces a careful investigation of the facts surrounding the problem. The BCA also provides a process for identifying critical parameters using sensitivity analysis. In the case of the CPP (and many other regulations), the BCA thereby informs the debate on both the philosophical underpinnings and the analytical basis for the decision.

Further, by honing the debate, the BCA provides an opportunity for analysts and researchers to improve information on elements that are the most important, such as the choice of an intergenerational discount rate. As suggested by a 2014 Special Issue of the Journal of Benefit-Cost Analysis, Perspectives on Implementing Benefit-Cost Analysis in Climate Assessment, a pplying BCA to climate change is challenging for many reasons, including the long time frame, the importance of intangible effects and the high degree of uncertainty along multiple dimensions—topics that researchers and policy analysts continue to explore.

While the changes to the SC-CO2 may raise concerns, it need not change how we present the fundamentals of BCA, nor the use and usefulness of BCA.

Elisabeth Gilmore is an associate professor in the Environmental Science and Policy program in the Department of International Development, Community and Environment at Clark University. In 2010 - 2011, she held an AAAS fellowship in the Climate Change Division of the Environmental Protection Agency.

The views expressed are those of the author and do not represent the Society for Benefit-Cost Analysis or other organization.

The Clean Power Plan and Benefit Cost Analysis will be discussed in a session at the upcoming annual conference of the Society for Benefit Cost Analysis. Register or find out more.